What to look for when purchasing multi family in a high market

[Deven Singh]

When purchasing a multi family in a high priced real estate market what pitfalls should you look for?

[Michael Ealy]

Originally posted by @Deven Singh:

When purchasing a multi family in a high priced real estate market what pitfalls should you look for?

 Whether the market is high or low, the pitfalls are the same. Below are the risks with multi family investing (and a lot of them are similar with single family investing):

1. Underwriting mistakes - if you over estimate the income/ underestimate the expenses (for example, you did not factor in that the property taxes will be higher when you take over), then this will cost you a lot since you will be overpaying for the building (since its value is proportional to the income)

2. Area/location could depreciate instead of appreciate - for example, in a lot of cities, people are moving away from the suburbs and into the city (as that is the trend among Millennials). Or, a major employer might move out of a city resulting in loss of jobs, which in turn increases vacancy and decreases rents. These examples will increase cap rates or decrease property values resulting in inability to sell the building or even inability to keep it due to significantly lower income

3. Financing risk -  To get higher cashflow, you need to get as low of an interest rate as possible combined with as long of an amortization period as possible (30 yrs vs 25 yrs for example). However, these lower interest/longer amo terms might come with short term balloon or short term fixed period (meaning the interest rate can go up after 5 years). Some investors make the mistake of getting the lowest interest rate but it's fixed for only 5 years and when the market turn, some of them get stuck with loans with interest that is rising significantly.

4. Unforeseen & Higher than Expected Capital Expenditures - this is true for older buildings or buildings in D and F locations. Capex and repairs are two of the variable or unpredictable expenses you can have in an apartment building. You can tighten this through proper underwriting but you can't predict it with 100% accuracy. There could be a big repair item festering behind the walls that you couldn't see during the due diligence that could bite you.

5. Inefficient Property Management - if you get bad property managers or if you yourself are not trained how to manage tenants and turnovers, then you can have serious problems. The role of PM is to increase your building's income and if you get a bad PM, your building's income will decrease and its value will drop like a rock. Many buildings go into foreclosure for the most part because of inefficient property management.